LECTURE NOTES “Dream! Act! Succeed!

”
AP – AUDIT OF RECEIVABLES Romeo T. Jamiro, CPA

ACCOUNTS RECEIVABLE In estimating for the Net Realizable Value of Trade accounts
Receivables – financial assets that represent a contractual receivable the following deductions are made.
right to receive cash or another financial asset from another a) Allowance for freight charge
entity. Usual types of receivables are accounts receivable and b) Allowance for sales return
notes receivable. Classified as Trade receivables & Non – c) Allowance for sales discount
trade receivables. d) Allowance for doubtful accounts

Trade receivables - expected to be realized in cash within a Methods of recording credit sales
normal operating cycle or one year, whichever is longer are 1) Gross method – the accounts receivable and sales
classified as current assets. are recorded at gross amount of the invoice.
2) Net method - the accounts receivable and sales are
Nontrade receivables – expected to be realized within one recorded at net amount of the invoice.
year, the length of the operating cycle notwithstanding, are
classified as current assets. If collectible beyond 1 year, Methods of Accounting for Bad Debts Loss
classified as noncurrent assets. 1) Allowance method – requires recognition of bad
debt loss if the accounts are doubtful of collection. If
Examples of nontrade receivables: it is proven to be worthless it is written off.
a) Advances to or receivables from shareholders , directors, 2) Direct write-off method - requires recognition of bad
officers(SILENT: Other Non-Current Assets) or employees debt loss only when the account is prove tp be
(SILENT: Non-trade Receivable-Current Asset). worthless or uncollectible.
b) Advances to affiliates usually treated as long term
investments. Method of estimating doubtful accounts
c) Advances to supplier (Non-trade Receivable-Current  Doubtful accounts are recognize when the loss is
Asset) probable and the amount can be estimated reliably.
d) Subscription receivables (Stocks: Current=Non-trade 1) Aging of the accounts receivable or “Statement of
Receivable; Non-current=Equity Component-deduction) financial position approach”.
e) Debit balances in the creditors account (Non-trade 2) Percent of accounts receivable or also the
Receivable-Current Asset) “Statement of financial position approach”.
f) Special deposits(SILENT: Other Non-Current Assets) 3) Percent of sales or “Income statement approach”
g) Accrued income(Non-trade Receivable-Current Asset)
h) Claims receivable(Non-trade Receivable-Current Asset) RESULTS PRO’S CON
Aging Required Accounts Matching
Customer credit balances – credit balances in accounts allowance for receivable are principle
receivable resulting from overpayment, returns, and DA at the fairly valued.
allowances, and advance payments from customers. period
Classified as current liabilities and should not be offset Percent of Required Accounts Matching
against other customer debit balances except if the amount is Accounts allowance for receivable are principle
immaterial. receivable DA at the fairly valued.
period
Initial measurement of receivables Percent of Doubtful It is in The Accounts
“PAS 39, paragraph 43, provides that financial asset sales account accordance receivable
should be recognized initially at Fair value plus transaction expense of with matching are not
costs that are directly attributable to the acquisition.” the period. principle. shown at net
realizable
Short term receivables – fair value is equal to the face value value.
or original invoice amount.
Long term interest bearing receivables – face value
Long term noninterest bearing receivables – present value
NOTES RECEIVABLE
Subsequent measurement of receivables is at net realizable Notes receivable – are claims supported by formal promises
value. to pay usually in the forms of notes.
Dishonored notes – a matured promissory note that is not
paid.

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 and a certain entity, where the factor purchases all of the
Initial Measurement entity’s accounts receivable.
Short term notes are measured - Face Value.
Interest bearing long term notes - Face Value D. Discounting of Notes Receivable – a form of receivable
Noninterest bearing long term notes - Present Value (sum of financing where notes are discounted in the bank or in
all future cash flows discounted using the prevailing market any financial institution in order to obtain cash.
of interest for similar notes). Terms related to discounting of note:
a. Net Proceeds
Subsequent measurement @ Amortized cost using the Net proceeds = Maturity value minus Discount
effective interest method. b. Maturity Value
Maturity value = Principal plus Interest
LOAN RECEIVABLE c. Maturity Date
Loan receivable – a financial asset arising from a loan granted d. Principal ( Face Value)
by a bank or other financial institution to a borrower or client. e. Interest
Interest = Principal x Rate x Time
It is measured initially @ Fair Value plus transaction cost that f. Interest Rate
are directly attributable to the acquisition of the financial g. Time
asset. Subsequent measurement @ Amortized cost using the h. Discount
effective interest method. Discount = Maturity value x Discount rate x Discount
period
Direct Origination Cost – cost that are directly attributable to i. Discount Rate
the loan receivable. (ADDITION-Transaction Cost) j. Discount Period
Origination fees – fees charged by bank against the borrower
for the creation of the loan.(DEDUCTION) Accounting for Note Receivable Discounting
- It depends on whether the discounting is with or without
Impairment loss – recoverable amount is less than the recourse.
carrying amount. *Discounting Without Recourse
- the sale is absolute and therefore there is no contingent
RECEIVABLE FINANCING liability.
Receivable financing – is the financial flexibility or capability *Discounting With Recourse
of an entity to raise money out of its receivables. - it may be accounted for either
Common forms of receivable financing: 1. Conditional Sale
a. Pledge of accounts receivable 2. Secured Borrowing
b. Assignment of accounts receivable
c. Factoring of accounts receivable Discounting Own Note
a. Casual factoring -The note is made by the party discounting with primary
b. Factoring as a continuing agreement liability.
d. Discounting of notes receivable -In effect, the party discounting is entering into a contract of
loan with the endorsee.
A. Pledge of Accounts Receivable – a form of receivable
financing where all accounts receivable are pledge as
collateral security for the payment of the loan. (Informal INTERNAL CONTROL MEASURES
Assignment of Receivables). 1. Proper internal control over receivables should observe
the following:
B. Assignment of Accounts Receivable – it is a more formal a. Sales must be separated from the accounting for
form of pledging of receivables, where a specific them.
account/s are assigned by the borrower(assignor) to the b. Accounting for sales must be separated from the
lender(assignee) in consideration for a loan. receipt of cash arising from receivables.
c. Returns, allowances, discounts and uncollectible
C. Factoring – it is ordinarily considered as sale of accounts charge-offs must be properly approved and
receivable in a without recourse, notification basis. separated from the cash receipts function.
Casual Factoring – an ordinary sale of asset, wherein gain d. Periodically, receivables should be aged in order to
or loss on factoring is recognized. determine the actions and efficiency of the credit
Factoring as a Continuing Agreement – there is a department.
continuing agreement between the finance entity(factor)

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2. Notes receivable custodian should not have access to
cash or to the accounting record.
3. A responsible official who does not have access to the
notes should approve note renewals as well as charge-
offs of defaulted notes in writing.
4. Proper procedures should be adopted for the follow-up
of defaulted notes.
AUDIT OBJECTIVES
Sales and Accounts Receivable Balances:
1. Existence or Occurrence: Sales and accounts receivable
are for shipments made to customers.
2. Completeness: Sales transactions that occurred and
existing receivables are recorded.
3. Rights and Obligations: Receivables are owned by the
client. Receivables represent valid claims against
customers and other parties.
4. Valuation and Allocation: Receivables are properly
measured or valued. The related allowance for doubtful
accounts, returns and allowances, and discounts are
reasonably adequate and considered.
5. Presentation and Disclosure: Sales and accounts
receivables are properly presented and disclosed in
accordance with GAAP.
Sales Transactions:
1. Completeness: Sales transactions that occurred are
recorded. For a sample of shipping documents, trace
sales invoice and entry into sales journal and accounts
receivable subsidiary ledger.
2. Occurrence: Recorded sales are for shipments actually
made to customers. For a sample of entries in the sales
journal, compare sales invoice copy and customer order.
3. Valuation: Sales are correctly billed and recorded. For a
sample of entries in sales journal, examine sales invoice,
shipping document and customer order for consistency
of descriptions and quantities; examine sales orders for
credit approval; and check prices and extensions.
AUDIT PROCEDURES
1. Obtain a list of aged accounts receivable balances from
the subsidiary ledger, and;
 Foot and cross-foot the list.
 Check if the list reconciles with the general ledger
control account.
 Trace individual balances to the subsidiary ledger.
 Test the accuracy of aging.
 Adjust non-trade accounts erroneously included in
customers’ accounts.
 Investigate and reclassify significant credit balances.
2. Test accuracy of balances appearing in the subsidiary
ledger.
3. Confirm accuracy of individual balances by direct
communication with customers.
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 Investigate exceptions reported by customers and
discuss with appropriate officer for proper disposal.
 Send a second request for positive confirmation
requests without any replies from customers.
 If the second request does not produce a reply from
the customer, perform extended procedures, like:
o Reviewing collections after year-end.
o Checking supporting documents.
o Discussing the account with appropriate officer.
 Discuss with appropriate officer, confirmation
requests returned by the post office and perform
extended procedures.
 Prepare a summary of confirmation results.
4. Review correspondence with customers for possible
adjustments.
5. Test correctness of cutoff:
 Examine sales recorded and shipments made a week
before and after the end of the reporting period and
ascertain whether the sales were recorded in the
proper period.
 Investigate large amounts of sales returned shortly
after the end of the reporting period.
6. Perform analytical procedures, like:
 Gross profit ratio
 Accounts receivable turnover
 Ratio of accounts written off to sales or balance of
accounts receivable
 Compare with prior year and industry averages.
7. Review individual balances and age of accounts with
appropriate officer, and:
 Determine accounts that should be written off.
 Determine adequacy of allowance for doubtful
accounts.
8. Obtain analyses of significant other receivables.
9. Ascertain whether some receivables are pledged,
factored, discounted or assigned.
10. Determine propriety of financial statement presentation
and adequacy of disclosures.
11. Obtain receivable representation letter from client.
“A dream doesn’t become reality through magic;
it takes sweat, determination and hardwork.”
– Colin Powell